It always starts like this – I save (for example) 15% toward retirement, spend 28% on my mortgage, and between Social Security and Medicare 7.65% comes off the top. This is 50% of my income that I won’t have to spend once retired, so a starting point is that I’ll need 50% of my pre-retirement income to retire at the same lifestyle once retired. Add another 20% or so as a buffer for increased medical expenses as I get older, and 70% should be more than enough. Right?

Not so fast, says Dan Ariely, behavioral economist and author of best sellers, Predictably Irrational and The Upside of Irrationality. In his recent blog post Asking the right and wrong questions Dan suggests that this method (what I call a top-down approach) underestimates the required income for the lifestyle people desire during their retirement. Dan suggests that instead of using the method I started with, that we look not at our current budget and reduce from there, but rather ask the key questions “How do you want to live in retirement? Where do you want to live? What activities you want to engage in?” In Dan’s study (which isn’t shared or linked to, unfortunately) by asking these questions he discovers an average result of 135%.

Let’s take a step back and understand the implications of this. Assuming social security replaces 35% of pre-retirement income (accurate at a $70K income level), then for the 70% replacement, only 35% more is needed, vs 100% as the gap for Dan’s 135% total. This is nearly three times the required retirement savings. If we rely on a 4% withdrawal rate as being safe, it would take 25 times the first year withdrawal as a total amount saved. Just under 9 times your final income to replace 35%, but 25 times final earnings to replace that 100%. Ouch. Considering how low the savings rate is in the US, these numbers are pretty intimidating. I don’t know if these studies serve as a wake up call that we need to save more or if they are just a source of discouragement, showing us how far we are from a satisfying retirement.

What do you think of Dan’s article? How will it impact how you look at what you’ll need to retire?

MattNovember 12, 2011, 2:29 pm

One doesn’t really need to look further than calculating their monthly expenses and work to create residual income vehicles/streams of income to exceed that number. Why worry about a withdrawal rate? Why worry about how much to save? This is the difference between an “accumulation” mindset and a “residual income” one. The accumulation mindset is failing this country’s people. It works for very few, and for those that it does work for either lower their standards and quality of life in retirement or they spend their retirement years worrying if they “accumulated” enough to last them their lives.